What are the types of profit and how to calculate it

Profit is the main indicator of the company’s success. To determine it, you need to know the income and expenses. But in business, it is customary to allocate different types of income and expenses, which means that there will be several types of profit. The article is devoted to the analysis of concepts related to profit generation, its calculation, as well as ways to increase it.

The difference between profit, revenue and income

For an uninitiated person in business or accounting, these three concepts are not much different. They are really similar, since each of them involves receiving funds as a result of trading operations. But there is a difference:

1. Revenue is the money that an entrepreneur received as a result of the sale of his product or service. For example, in a coffee shop, this will be the money accumulated in the cash register during the working day from the sale of drinks, pastries, desserts.
2. Income is the sum of revenue and additional income not related to the sale of specialized services or products. For example, the shipping company delivered the cargo. The customer did not pay on time, for which he paid a penalty, which is not considered income, but is revenue. Income can increase due to an increase in the value of property or a decrease in the value of the organization’s obligations. For example, if an organization has a foreign currency account and money is on it, then they are considered part of the property. An increase in the exchange rate will increase the size of this property. If a company has taken out a loan in foreign currency, and by the time it is repaid, the exchange rate has fallen, then it will also receive income due to the exchange rate difference.  If there are no additional receipts for the month, then the income will be equal to the revenue.
3. Profit is the difference between earned and spent funds. It is always less than revenue and income, and in some cases (if the company spent more than it earned) it is generally negative, i.e. a loss.

What types of profit are distinguished

Clean

This is the difference between all types of income and expenses, including tax and debt payments. Illustrates how successful the company’s commercial activities are. Banks are guided by it when they decide whether to issue a loan to an organization and in what amount. The higher and more stable the net profit, the more willing financiers are to lend to the company.

Gross

This is the difference between the amount earned from the sale of products and the cost of its production. There is no exact list of costs that make up the cost price, because the list will be different for each type of product. If this is industrial production, the cost includes the cost of raw materials, their transportation, electricity payments, etc. If we are talking about trade, then the cost includes the cost of purchasing a batch of goods, packaging, delivery, customs clearance, payment for intermediaries (if any). The cost does not include management costs, rental fees and costs that are not directly related to the trading or production process. The salary of employees engaged in production is included in the cost price, but the salary of staff who, for example, only maintains computers is not.

The calculation of gross profit helps to assess the profitability of each line of business, i.e. to find out how much money had to be spent to earn the resulting amount. This indicator is especially important if the business operates simultaneously in many directions and it is necessary to determine the most profitable ones.

Operating room

This is the total amount of profit minus current expenses, as well as depreciation of equipment, but before interest on loans and loans, as well as taxes. Operating expenses are divided into:

• commercial, including the cost of selling a product or service (advertising, rental of premises, delivery of components, packaging, utility fees);
• management costs are costs that are not directly related to the production process, but are necessary for its regular functioning (include the purchase of stationery, payments for communication, payment of salaries to employees, maintenance of equipment).

This economic indicator helps to assess the profitability of activities without taking into account tax and credit payments.

Margin

This is the difference between revenue and non-permanent, i.e. recurring, expenses, for example, the cost of consumables, raw materials, and payment for contractors’ services. It helps to understand the expediency of selling a particular product.

Unallocated

These are the funds that have accumulated in the company’s accounts over all the years of operation, and they have not been spent on anything. The presence of retained earnings is an indicator of a firm’s good performance, meaning that it spends less than it earns. Part of this profit can be used to increase the authorized capital, while the other can be used for payments in the form of dividends or bonuses.

Balance sheet

This is the total amount used to calculate taxes.

Economic

This is net profit minus internal and external costs. Helps to evaluate the efficiency of the company’s resource allocation. By analyzing implicit costs, you can optimize your business and reduce the cost of running it.

Accounting

This is sales revenue minus external costs, calculated once a year at the end of the financial period and reflects the financial success during the reporting period. If the income is higher than the expenses, then there is a financial profit. If the expenses are higher, it means that the year has ended with a loss. If the indicators are equal, then the profit is zero.

Lost (lost profit)

This is the part of the money that the company failed to receive as a result of the actions of third parties. For example, a transport company that violated the delivery time, or a supplier who did not ship the shipment on time. As a result of these actions, the company will be forced to cancel pre-placed customer orders and will not receive the money it expected. The lost profit is considered in order to determine the amount of the penalty to be charged to the counterparty.

EBITDA

This indicator is a kind of profit and one of the tools for analyzing the work of an enterprise. EBITDA is net income increased by the amount of income tax (a major type of expense), interest and depreciation. EBITDA shows the company’s ability to pay tax and credit obligations, as well as to make capital expenditures.

How profit indicators are analyzed and why it is necessary

The calculation is necessary in order to know in which direction to develop the company’s activities. But in order to assess the profitability of the work as accurately as possible, it is also necessary to analyze the indicators, while simultaneously using several methods:

1. Temporary (horizontal). It involves comparing digital data for the current financial period and similar intervals in previous years: for a month, quarter or half a year. A comparative analysis will show whether there is progress in business development.
2. Structural (vertical). Reflects what money is spent on: taxes, loans, direct, indirect expenses, etc.
3. Competitive. This type of analysis is difficult due to the fact that accounting statements from a competing firm will be required, which cannot be obtained simply on request. However, there are options, for example, the analysis of Rosstat’s annual reports on industries where industry-wide digital data is freely available.

Tracking each type of profit will tell you the best way to develop your business:

• where does he lose or lose;
• what you can save on;
• which product should I refuse;
• which production is better to scale.

Functions of the received profit

The main function is an indicator of the economic profitability of a business, expressed in monetary terms. It is invested in scaling up the business, increasing salaries to employees, and improving working conditions. The overall level of profit is used to judge the effectiveness of the company, competitiveness, and quality of goods and services. There are also specific functions:

1. An assessment that helps to analyze the financial and economic situation in which the company is currently located.
2. Stimulating, because it helps to identify the most promising areas of business development and discard unprofitable ones.
3. The controlling one. Helps to evaluate the company’s activities.
4. Reproductive. Shows the difference between the revenue and expenditure parts of the activity.
5. Fiscal, responsible for generating tax revenues to the state budget.

Ways to increase profits

Based on the definition of the concept, there are two ways to increase:

• increase in income;
• cost reduction.

Ways to increase income

1. Increase in sales volume.
2. An increase in prices, but within reasonable limits, so as not to lose competitiveness and automatically reduce sales.
3. Expansion of the product line.
4. Product quality improvement. This will increase prices while maintaining sales volume.
5. Expansion of the sales market.
6. Search for additional ways to earn money, for example:

• placement of available funds on bank deposits at interest;
• placement of partner ads on their virtual platforms;
• leasing of empty premises, as well as unused equipment;
• the organization of related small industries from the waste of the main activity, for example, the organization of a workshop for sewing soft toys from the waste of sewing production.

Ways to reduce costs

1. Optimization of production through the introduction of new, more efficient technologies that will help reduce production costs, as well as reduce losses by reducing the number of defects.
2. Reducing the cost of production (find cheaper raw materials or buy them not from an intermediary, but from the manufacturer).
3. Cost rationing. This technique implies that the warehouse should store exactly as many raw materials and components as are necessary for the smooth operation of the enterprise, but no more. Raw material surpluses are at the same time unnecessary expenses, storage problems, and the threat of spoilage.
4. Optimization of loans. Additional funds are always required for the development of production – loans. However, when making them, it is important to calculate the most rational amount so as not to lose interest during the period when work is not underway. That is, if money is needed several times a year for short periods (for example, for seasonal processing of products), it is better to issue loans for small amounts several times than to take out a large one at once for the whole year.
5. Setting up logistics. This technique implies the optimization of the system of placement of production workshops, warehouses, points of sale, which will reduce the cost of transportation.

There are many types of profit, some of them belong to the main ones, the other to the secondary ones. But you should not neglect any of them, since each is designed to highlight a separate side of the business. At the same time, all types of expenses and income taken into account when calculating profits are closely interrelated: a change in some invariably entails a change in others. In order to ensure the company’s stable progressive development, all indicators must be verified and balanced.